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Cost Volume Profit Relationships Exercise

Magic Realm produced a new board game last year, selling 15,000 units at $20 each with total fixed costs of $182,000 and variable costs of $6 per unit. This resulted in a contribution margin of $14 per unit and net operating income of $28,000. The degree of operating leverage was calculated to be 7.5. It was projected that an increase in sales to 18,000 units next year would increase net operating income by 150% to $70,000 due to this high degree of operating leverage. Outback Outfitters sells camp stoves for $50 each with variable costs of $32 and fixed costs of $108,000 per month. The break-even point

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252 views2 pages

Cost Volume Profit Relationships Exercise

Magic Realm produced a new board game last year, selling 15,000 units at $20 each with total fixed costs of $182,000 and variable costs of $6 per unit. This resulted in a contribution margin of $14 per unit and net operating income of $28,000. The degree of operating leverage was calculated to be 7.5. It was projected that an increase in sales to 18,000 units next year would increase net operating income by 150% to $70,000 due to this high degree of operating leverage. Outback Outfitters sells camp stoves for $50 each with variable costs of $32 and fixed costs of $108,000 per month. The break-even point

Uploaded by

Avronil Anik
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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Download as DOCX, PDF, TXT or read online on Scribd
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EXERCISE 5–15 Operating Leverage

Magic Realm, Inc., has developed a new fantasy board game. The company sold 15,000 games
last year at a selling price of $20 per game. Fixed expenses associated with the game total
$182,000 per year, and variable expenses are $6 per game. Production of the game is entrusted to
a printing contractor. Variable expenses consist mostly of payments to this contractor.
Required:
1. Prepare a contribution format income statement for the game last year and compute the
degree of operating leverage.
2. Management is confident that the company can sell 18,000 games next year (an increase
of 3,000 games, or 20%, over last year). Compute:
a. The expected percentage increase in net operating income for next year.
b. The expected total dollar net operating income for next year. (Do not prepare an
income statement; use the degree of operating leverage to compute your answer.)
1.
Total Per Unit
Sales (15,000 games) 300,000 20
Variable expenses 90000 6
Contribution margin 210,000 14
Fixed expenses 182,000
Net operating income 28,000

The degree of operating leverage is:


Degree of operating leverage = Contribution margin/ Net operating income
= $210,000/$28,000
= 7.5
2 a. Sales of 18,000 games represent a 20% increase over last year’s sales. Because the degree
of operating leverage is 7.5, net operating income should increase by 7.5 times as much, or by
150% (7.5 × 20%).

b. The expected total dollar amount of net operating income for next year would be:
Last year’s net operating income ....................................................................................28,000
Expected increase in net operating income next year (150% × $28,000) ......................42,000
Total expected net operating income ...............................................................................70,000

EXERCISE 5–17 Break-Even and Target Profit Analysis


Outback Outfitters sells recreational equipment. One of the company’s products, a small camp
stove, sells for $50 per unit. Variable expenses are $32 per stove, and fixed expenses associated
with the stove total $108,000 per month.
Required:
1. Compute the break-even point in unit sales and in dollar sales.
2. If the variable expenses per stove increase as a percentage of the selling price, will it
result in a higher or a lower break-even point? Why? (Assume that the fixed expenses
remain unchanged.)
3. At present, the company is selling 8,000 stoves per month. The sales manager is
convinced that a 10% reduction in the selling price would result in a 25% increase in
monthly sales of stoves. Prepare two contribution format income statements, one under
present operating conditions, and one as operations would appear after the proposed
changes. Show both total and per unit data on your statements.
4. Refer to the data in (3) above. How many stoves would have to be sold at the new selling
price to yield a minimum net operating income of $35,000 per month?
1. Profit= Unit CM*Q-Fixed Expenses
0 = (50-32) * Q – 108,000
Q = 6,000 stoves, or at 50 per stove, $ 300,000 in sales.
2. An increase in variable expenses as a percentage of the selling price would result in a
higher break-even point. If variable expenses increase as a percentage of sales, then the
contribution margin will decrease as a percentage of sales. With a lower CM ratio, more
stoves would have to be sold to generate enough contribution margin to cover the fixed
costs.
3. Nnnnn
Present 8,000 Stoves Proposed 10,000 stoves
Total Per Unit Total Per Unit
Sales 400000 50 450000 45
Variable expenses 256000 32 320000 32
Contribution Margin 144000 18 130000 13
Fixed Expenses 108000 108000
Net Operating Income 36000 22000
8000 stoves at 1.25 = 10,000 stoves
50 at 0.9 = 45
As shown above, a 25% increase in volume is not enough to offset a 10% reduction in the selling
price; thus, net operating income decreases.
4. Profit = Unit CM × Q − Fixed expenses
$35,000 = ($45 − $32) × Q − $108,000
$35,000 = ($13) × Q − $108,000
$13 × Q = $143,000
Q = $143,000 ÷ $13
Q = 11,000 stoves

Alternative solution:
Unit sales to attain target profit =Target profit + Fixed expenses/ Unit Contribution
Margin
= $35,000 + $108,000/ $13
= 11,000 stoves

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